The decline in stock prices triggered by the U.S. financial crisis has
been frightening at times. Most shocking has been the sheer velocity
of the decline, which rivals that of the crash of 1929. And despite a
recent rally, there is enough bad news to push stock prices back
down. But unless you believe the global economy will grind to a halt;
I see five reasons why investors should be optimistic today.

Governments are taking action

Many have been comparing today's crisis to the Great Depression and
the Japanese deflationary spiral to gain insight into how things may
unfold. But a key difference between what happened in those two
previous instances and the current crisis is the extent, speed, and
coordination of government action. During the Great Depression, the
government responded much too slowly. The many bad loans that brought
down Japanese banks were covered up.

Today we're not only seeing the U.S. government move aggressively to
unfreeze credit markets; we're also seeing a coordinated global effort
by central banks and governments across the globe to prevent this
crisis from turning into a depression. You can point out imperfections
in the solutions proposed thus far, but I'll take an approximately
correct solution over inaction any day.

History is on our side

Peak-to-trough losses from the current bear market are clocking in
anywhere from -40% (North American stocks) to -56% (emerging markets
stocks). And, at the time of writing, prices have bounced up a bit
from there. But viewing those losses in the context of history reveals
that this is a very typical bear market.

I studied the monthly returns of U.S. stocks (in U.S. dollars) from
January 1926 through September 2008. There have been seven distinct
instances of U.S. stocks losing 20% or more from
peak-to-trough. U.S. bear markets have posted average losses of 39%
and took 16 months to reach their respective lows. After touching
bottom, U.S. stocks took an average of 43 months (about 3.5 years) to
recover to previous highs.

Also, previous instances of 40% declines in U.S. stocks were followed
by decades of handsome returns. More specifically, the subsequent
ten-year annualized returns clocked in at a median of 9% annually. The
1929 Crash (which saw U.S. stocks lose almost 90%) drags down that
average but investing in U.S. stocks after losing 40% or more has - so
far - never been a losing proposition when measured in ten-year
increments.

Balanced portfolios are doing okay

Much of my analysis over the past month has focused only on
stocks. But, with few exceptions, we simply do not recommended 100%
stock portfolios for anybody. (One exception I've made to this rule in
the past, for example, has been for someone with a very small RRSP who
has a generous pension plan.)

Looking, then, to what the past tells us about balanced portfolios is
instructive. While a portfolio of 60% U.S. stocks and 40% U.S. 5-year
Treasury bonds still lost 62% at the worst of the Great Depression, it
recovered from that punishing loss in 45 months. That's a gain of 168%
from the low (almost 15% annually). The entire trip, from
peak-to-bottom-to peak took a total of 6.5 years. A portfolio of 100%
U.S. stocks spent more than 15 years under water, in large part
because it lost so much more.

Today's balanced portfolios have surely been dented but not
irreparably. A portfolio of 60% stocks and 40% bonds is showing a loss
of about 23% through October 17. I know that's not pretty but it's not
without precedent. Almost exactly six years ago, a similar portfolio
would be showing a 21% loss. Not great, but not terrible.

Stocks are cheap

The most encouraging sign I see today is the abundance of cheap stocks
that are available today. True, stocks could get cheaper. But close to
half of the stocks in the S&P/TSX 60 Capped Index trade at 10 times
their latest annual earnings, or less. There are hundreds more
U.S. stocks trading at similar prices, including stocks of almost two
hundred medium and large companies.

Another by-product of falling prices is higher dividend
yields. Indeed, there is a proliferation of stocks offering a dividend
yield of 4% and higher. Broad market indexes - like the S&P 500 - are
trading at composite dividend yields not seen since the early
1990s. So, unless you think the economy will vanish and earnings will
disappear, today's prices are very attractive.

Legendary investors are buying today

Several legendary investors have spoken publicly about their personal
investing in recent weeks. Perhaps the most widely circulated article
of late was Warren Buffett's Op-Ed piece in the New York Times. The
title, 'Buy American. I am.' says it all. But other seasoned
investors, such as Marty Whitman and John Neff, are adamant that a
rare buying opportunity is before us. I wouldn't bet against these
legends.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in
Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and
provides independent investment research to financial advisors. He can be
reached at dha@danhallett.com

Disclaimers: Consult with a
qualified investment adviser before trading. Past performance is a
poor indicator of future performance. The information on this site,
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